I'm a Fellow at the Adam Smith Institute in London, a writer here and there on this and that and strangely, one of the global experts on the metal scandium, one of the rare earths. An odd thing to be but someone does have to be such and in this flavour of our universe I am. I have written for The Times, Daily Telegraph, Express, Independent, City AM, Wall Street Journal, Philadelphia Inquirer and online for the ASI, IEA, Social Affairs Unit, Spectator, The Guardian, The Register and Techcentralstation. I've also ghosted pieces for several UK politicians in many of the UK papers, including the Daily Sport.

This is a nice catch from Don Boudreaux: Senator Bill Cardin wants to stop “excessive speculation” from driving up gasoline prices. But this is the same Senator Bill Cardin who supports a carbon tax in order to, err, drive up the price of gasoline. It’s one thing if a politician proposes something you don’t like, all of them do that at some point or other. But can’t we demand that they be consistent?

As it happens I agree with the idea of a carbon tax precisely to drive up gasoline prices (Boudreaux would not agree with me here) and thus support that part of Senator Carin’s proposals. But I’m also entirely happy for “excessive” (whatever that actually means) speculation to change the price of it too. Except that Senator Cardin, plus the 14 other Senators who have signed on to the same bill, seem not to actually understand the oil market in the slightest. At least I assume that’s the case: no one who did understand it would propose the silliness that they are proposing.

For they’ve missed three rather important points: firstly that the oil market is a global one, not one limited to the US. Secondly that futures speculation doesn’t change the price of gasoline one whit and thirdly, most importantly, we actually desire the effects of speculation upon prices in the economy.

Here’s what they’re actually complaining about and the list of people signed up to this idea is Bernie Saunders, Ben Cardin and:

The basis of their analysis is that US gasoline supply is up, US gasoline demand is down therefore rising prices can only be as a result of that excess speculation:

While developments in Iraq have had no impact on the supply of gasoline in the United States today, gas is more expensive now than it’s been in six years at the beginning of the summer driving season, according to AAA. The increase has occurred despite the fact that the supply of gasoline is 4.3 percent higher and demand is 1 percent lower than it was five years ago, when national gas prices averaged $2.69 a gallon.

That’s a really quite staggering piece of analysis. Reflecting an almost pure, possibly even childlike, ignorance of how supply and demand actually work. There is no such thing as the “supply” or “demand” for anything. There is, however, the “supply at a price” or the “demand at a price” for something. The current supply of gasoline at $2.69 a gallon in the US is around and about zero. As everyone can get $3.50 or more for it no one at all is willing to sell it for $2.69 thus the supply at that price is none. Similarly, the demand for gasoline at $2.69 is probably rather larger than the demand for it at $3.50. Higher prices tend to have that effect, reducing demand. So it isn’t that supply has risen, demand has fallen, therefore gas prices should be lower. Rather, it’s that prices have risen thus supply is larger and demand lower.

They’re also entirely ignoring the fact that the price of gasoline in the US is not determined by the supply and demand in the US. It’s true that US produced crude cannot be exported but gasoline can be (and is) both imported and exported. That means that Ricardo’s Iron Law of One Price comes into play and the price of gasoline in the US is determined by the global balance of supply and demand. Just looking at the US situation simply doesn’t work.

But I’m afraid that it gets worse too. The Good Solons are demanding that the CFTC do something about all of this. But the CFTC is the Commodity Futures etc: they deal with futures, not physical trading of oil. And as Paul Krugman has pointed out repeatedly and vehemently, futures trading doesn’t affect the price of physical commodities. Physicals only change in price dependent either upon real demand and supply issues or, if there is speculation in the market, on the building up or running down of physical stocks of that commodity. And the CFTC doesn’t deal with such physical stocks: so even if the Senators were right in that something nefarious is going on, something nefarious that should be stopped, they’re still asking the wrong people to do something about it.

And finally there’s an even worse problem with their demand. We actually like people speculating in oil and other commodities. It’s a good thing for both us and the rest of the economy that it happens. For what it does (that sort of hoarding of physicals that does change the current market price) is it moves prices through time. And this is a thoroughly good idea.

This was all laid out 238 years ago by Adam Smith so you would rather hope that people could grasp it by now. His example was a wheat merchant but the same point is valid today about oil. Imagine that there is the possibility of some shortage of something (anything, trainloads of whatever if you like) in the future. What we would like to happen is that people do two things. That consumers use a little less of whatever in the present: this will preserve that limited supply. Also, we’d like people to go out to their whatever mines and produce a bit more of it. This will aid in getting us over that possible future shortage. A good way of encouraging all of this to happen is that the price of whatevers rises. This reduces demand and increases the incentive to supply.

Add our speculators into this mix. They see the story that there might be a shortage in the future. So, they buy some now and store it. This raises the price now: note that “now” there. So, instead of waiting for the shortage to arrive and then prices rising the speculators have raised the price today. This means that we all use a little less today and that there’s likely to be a little more supply, starting today, as well. The net effect of all of this is that when that predicted shortage does arrive then it’s not going to be as bad as it could have been. Because, obviously, we’ve all been using a little less and producing a bit more as a result of the rise in the price.

And there’s one more stage in this speculation story. Those speculators only get to make a profit if they’re right about the coming shortage (or, when working the other way, about a glut). If they’re wrong and it never arrives then they lose money: if they’re right and prices do rise with the shortage then they make it. So, they only get a reward if they have actually led the rest of us into desirable behaviour: reducing consumption now and increasing production.

So these 15 Senators are really proposing something quite alarmingly stupid. You cannot measure supply and demand independently of price yet that’s the core of their argument, that they have. They seem to think that the gasoline market price is determined by US factors only when it’s actually global. They then are looking to regulations in the futures market when futures don’t have anything to do with physical market prices and finally, they’re entirely unaware that even if all of these three things were indeed as they assume them to be then we’d actually want to have the influence of the speculators anyway.

It’s difficult to avoid the thought that there must be a better way to run a country than this: unfortunately, as Churchill remarked, democracy is a terrible political system except for all the other ones we’ve ever tried. They’re all worse.

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In it, Mr. Worstall speaks to one benefit of “excessive speculation” in the oil market: speculation’s potential effects on future supply and demand. If we are just talking about this one aspect of futures markets, his point seems sound.

The smart distinction that Mr. Worstall makes, between an item and its price, is an important one. As a nation, we are generally ignorant of finances and economics.

(If instead of lobbying so hard—and so mockingly—against this ignorance, Conservative Americans put that energy into actual education and reduction of that ignorance, then (A) we might all suffer less of it and (B) the Right could legitimately lose its presumption of selfishness, hard-heartedness, and inadequate compassion.) ____________________

Mr. Worstall seems to believe that while extra-industry participants in a market might create some disruption for those indigenous to that market, this is no reason to restrict the market. Even if some such reasonable restrictions could be devised.

Here, in terms of “indigenous,” I’m thinking of American tourists buying up quaint tortilla presses in Mexican street markets, raising the cost for the peons who actually rely on them.

And I’m also thinking of wholesale, merchandise markets that are closed to the retail trade:

Should all such markets be completely open?

What relevant differences obtain, between commodities markets and the futures vehicles for those markets? ____________________

In the “Comments” section to the referenced Don Boudreaux post, one George Balella, Jr., writes, “…[Dr. Boudreaux]…loves paying extra in oil prices for people who both lobbied for changes to commodities rules and now tax the professor on his oil purchasing using their advantage of asymmetrical information…He…forgets that they already did mess with the market…in 1991, when…Goldman Sachs made an argument to the Commodity Futures Trading Commission that Wall Street dealers who put down big bets on oil should be considered legitimate hedgers and granted an exemption from regulatory limits on their trades….Why is it OK for legislators to change the rules in to the desires of the monied interest but when they want to change the rules to help the average person the professor always sides with the money interest of the rent seekers…?”

How does this assessment fit in with the “stupid” and “imbecile” one? ____________________

Also, U.S. Senator Ben Cardin’s website reports that, “Exxon Mobil, Goldman Sachs, the International Monetary Fund, the St. Louis Federal Reserve, the American Trucking Association, Delta Airlines, the Petroleum Marketers Association of America, the New England Fuel Institute, the Consumer Federation of America and others have blamed excessive oil speculation for significant increases in oil and gas prices.”

Like Mr. Worstall, I don’t understand how this view can be correct. But if it were correct, then at least the “stupid” (per Mr. Worstall) “imbecile” (per Dr. Boudreaux) Senator Cardin appears to be in good company. ____________________

Beyond the main issue he presents, is Mr. Worstall’s overall assessment valid?

Worstall, seriously, you need to find another occupation. You are wrong, consistently on all matters of commerce. If consistency were virtue, you would have your reward.

You are wrong about 1) Ricardo 2) gasoline prices 3) futures speculation not changing the price of gasoline

1) Ricardo never wrote about an “iron law of one price” as you wrongly put it, Worstall. It was Germans who stuck Ricardo with the phrase, “the Iron Law” and it has to do with wages only and not other prices.

Ricardo claimed there is a tendency for population to rise as soon as wages would rise above bare necessaries to sustain living thus causing wages to be fixed to the prices of bare necessaries.

Thus, it can be seen there is no fictitious global balance of supply and demand that sets the price of gasoline in the USA.

Further, imports of refined gasoline can come into the USA profitably, only if outlays to refine elsewhere are low enough such that when combined with transport outlays, foreign producers can at least break even on prices set here in various regions of the USA.

As can be seen here by PADD (Petroleum Administrative Defense Districts) region, most foreign exporters of crude to Americans do not also export gasoline likely because it is not profitable to do so.

Sure, there are minor differences in gasoline prices across the US. Transport costs do exxist you know. Also there are local blends: it’s not an entirely homogenous market.

But that doesn’t cchange the fact that at the more general level gasoline prices are set by the international price of crude oil. If this were not true then gas prices would not move in lock step with that price of international crude. Given that they do therefore they must be so influenced.

There are significant gasoline exports from the US: so the market is so integrated.

Finally, it isn’t futures that determine the physicals price. Don’t argue with me about it, go take it up with Paul Krugman. He’s the guy with the Nobel, recall?